Banks must deal with the bad debt to restore trust

These are nervous times. There was a yelp from the passenger seat when Yanis Varoufakis, professor of economic theory at Athens University, mused in a radio interview on what would happen if Greece declared its departure from the euro.

These are nervous times. There was a yelp from the passenger seat when Yanis Varoufakis, professor of economic theory at Athens University, mused in a radio interview on what would happen if Greece declared its departure from the euro.

The good professor meant it by way of illustration, but my fellow listener took it as a forecast. She was all for heading to the bank with a suitcase to take her money out there and then.

Lots of money has, of course, already left the Irish banks, and the Greek banks, and probably other banks. Many ordinary Irish savers are probably running currency risk by having their money in sterling accounts. They might gain - but they might lose.

It's not remotely good enough to treat runs on banks - which is what this amounts to - as a temporary emergency and cover the losses with short-term loans, as the ECB chiefs have done.

The difficulty about doing anything more sensible is the same one as bedevils any movement on the crisis - that one thing leads to another, in directions in which people generally do not want to go.

It would be a great help, for instance, if the ECB gave longer-term loans to the banks that need them, and if it stood behind guarantees to small depositors.

But to do that, it, along with governments, would have to sort out good banks from ones with doubtful long-term prospects, and embark on closures, mergers and recapitalisations.

Since this has proved politically impossible - so far - we get measures that prevent immediate collapse but do not remove the threat of it.

As we respond to that threat, whether by withdrawing funds or declining to spend and invest in the real economy, the scale of any eventual bank collapse grows and economic output suffers.

This has been the Irish experience so far, and it may become the wider European experience.

The latest analysis and forecast from Davy Stockbrokers concludes that Irish households have elected to take a double hit to their standard of living.

They have added to the unavoidable one from higher taxes and reduced pay by choosing to spend less of what they have left as well.

The savings rate appears to be 13% of income at this stage. Much of this is paying down debt rather than adding to deposits - in whatever form - and one would expect that, given high levels of household debt.

But it seems safe to assume that some of it is a response to the darkening European and international outlook.

They have darkened all year, with the emergency summit in July as the Greek crisis began to spread, and the even more worrying current difficulties as Greece runs out of cash and the big peripheral economies face downgrades.

The World Bank has warned that a similar phenomenon threatens the more creditworthy countries in the euro area.

The banks are at the root of this problem. The plunge in leading European bank shares and the pressure on inter-bank lending indicate that markets now expect the banks to face up to sovereign writedowns and other bad debts, incur large losses and require lots of fresh capital.

The best thing euro-area governments can do is prove the markets right, and begin the long, painful process of building a system in which ordinary folk outside the markets can believe, and even trust.

Irish saving rate appears to be 13% of income at this stage - much of this is paying down debt